Managing an asset pool in terms of a recommended asset and withdrawal strategy is a problem encountered by individuals, foundations or other entities in a variety of circumstances. For example, this problem is often encountered by a retiree, an individual who has stopped working but has not stopped paying bills. Such an individual has grown accustomed to a certain standard of living and needs the resources to maintain it—as well as pursue the dreams the individual now has time for. The individual is about to start gathering income by harvesting from a portfolio of assets, for example the wealth accumulated during their working life. At this stage, one of the greatest risks the individual faces is outliving their accumulated wealth.
The invention—the SELIGMAN HARVESTER® risk management system and apparatus—provides a methodology for seeking investment solutions that retirees can live with right now, as well as 10, 20, or 30 years from now or for any time period. The invention is based on the interaction of: (1) a hypothetical distribution of investment outcomes for a specific asset allocation, and (2) specified fixed dollar and fixed percent withdrawal amounts to generate a hypothetical illustration of a distribution of possible portfolio values and withdrawal amounts over a designated time period to facilitate a recommended asset allocation and withdrawal strategy. The hypothetical distribution of investment outcomes is generated using a “Monte Carlo” (“MC”) software program which utilizes a random number generator and the actual rate of inflation (“CPI”) for each year going back to 1950 and the actual, year-by-year total returns for 75 different portfolios with different mixes of Domestic Large Cap, Mid Cap, and Small Cap stocks; International Large Cap, Mid Cap, Small Cap and Emerging Markets stocks; Corporate, Government and Inflation Index Bonds; and 30-Day Treasury Bills. In other words, the MC program selected the year-by-year actual returns in random order and then linked the corresponding returns for each of the 75 different portfolios.
Other authors have applied MC software programming to investment planning using an assumed average rate of return and an assumed standard deviation for each of the variables. See, e.g., Robert N. Veres, “The Monte Carlo Solution,” Dow Jones Investment Advisor at 35–38 (May 1996); Christopher J. Cordaro, “Using Monte Carlo Simulations for Retirement Planning,” Retirement Planning at 39–44 (July–August 1998). Veres also suggests using an existing optimizer program to calculate for a given asset mix, a historical average rate of return and standard deviation. For example, Veres says that the financial advisor can “run probability analyses on their optimizers to get a mean return and standard deviation. They can assume 3% annual inflation with a standard deviation of 1% or so . . . . ” Veres, page 36, column 2.
Thus, the approaches used by both Veres and Cordaro apply the MC software to generate the distribution of possible returns given the specified mean return and standard deviation. In contrast, by using the actual year-by-year returns (and limiting the MC software program to selecting the order of the years, and not generating the actual returns), the invention captures all of the cross correlations among the various asset classes in each year, and also relates them to the actual CPI for each year.
The invention interacts a hypothetical distribution of investment outcomes for a specific asset allocation with specified fixed dollar and fixed percent withdrawal amounts to generate a hypothetical illustration of a distribution of possible portfolio values and withdrawal amounts over a designated time period to facilitate a recommended asset allocation and withdrawal strategy. By using actual year-by-year returns for each portfolio and using the MC software only to randomly generate the sequence of years, thereby deriving a distribution of investment outcomes, the invention generates for a given withdrawal strategy a hypothetical illustration of a distribution of possible portfolio values and withdrawal amounts on an annual, quarterly or other basis, with probabilities for each time interval ranging from the worst case scenario to the best case scenario, e.g., the worst 10% to the best 10%.
The withdrawal strategy of the invention uses combinations of fixed dollar and fixed percent withdrawals and interacts them with the hypothetical distribution of investment outcomes for a specific asset allocation to generate a hypothetical illustration of year-by-year portfolio values and year-by-year withdrawal amounts, i.e., the Hypothetical Illustrator of the invention. In addition, the fixed dollar withdrawals of the present invention are increased or decreased by the change in CPI for the prior year, as selected by the MC software. As a consequence, the increase in the fixed-dollar withdrawal in any one-year also varies probabilistically according to the simulation results. In addition, the fixed percent withdrawal is based on year end portfolio values as given by the distribution of investment outcomes for each year. As a consequence, the actual dollar value of the fixed percent withdrawal in any one year also varies probabilistically according to the invention results.
The methodology disclosed by other authors differs markedly from the invention in that they only disclose fixed withdrawal amounts increased by an assumed inflation rate. See, e.g., Veres; Cordaro; Philip L. Cooley et al., “Sustainable Withdrawal Rates From Your Retirement Portfolio,” Department of Business Administration, Trinity University, San Antonio, Tex. 78212-7200; William P. Bengen, “Conserving Client Portfolios During Retirement, Part III”, Journal Of Financial Planning at 84–97 (December 1997); James K. Kennedy et al., “How Much Is Enough? A Guide To Planning A Retirement Portfolio,” Journal Of Financial Planning at 82–87 (June 1998). For example, in the Cordaro case for Bob and Carol Sample, in 2009, their withdrawal is $42,947. That withdrawal is increased by 3% a year, which is the assumed rate of inflation. Cordaro at 41, Exhibit 1. The amount of money withdrawn has no relation to the value of the portfolio.